BACKFLUSH COSTING

Definition of Backflush Costing :

A streamlined cost accounting method that speeds up, simplifies, and reduces accounting effort
in an environment that minimizes inventory balances, requires
few allocations, uses standard costs, and has minimal variances
from standard

Product costing approach, used in a just - intime (jit) operating environment, in which costing is
delayed until goods are finished. Standard costs are then flushed backward through the system
to assign costs to products. The result is that detailed tracking of costs is eliminated. The system
is best suited to companies that maintain low inventories because costs then flow directly to
cost of goods sold. Work-in-process is usually eliminated, journal entries to inventory accounts
may be delayed until the time of product completion or even the time of sale, and standard
costs are used to assign costs to units when journal entries are made, that is, to flush costs
backward to the points at which inventories remain.

Characteristics Of Companies Adopting Backflush Costing :

The companies adopting backflush costing often meet the following three conditions :

1. Management wants a simple accounting system and no detailed tracking of direct material
and direct labour through a series of operations is required.

2. Each product has a set of standard cost.

3. Material inventory levels are either low or constant.

If inventories are low, the bulk of manufacturing costs will flow into costs of goods sold and it is
not deferred as inventory cost. Backflush costing is especially attractive in companies that have
low inventories resulting from JIT.

What are the advantages of Backflush Costing :

1. Less entries have to be passed so it saves time. (major benefit)

2. Less costly as less documentation have to be maintained.

3. It uses JIT environment which saves holding cost of inventory

What are the disadvantages of Backflush Accounting :

1. One of the main disadvantages of the system is that it only works under some quite strict
requirements. If these are not met, the system will become unbalanced and may be quite
unusable, or a nightmare to maintain:

2. Standard costs must be reliably estimated and variances kept to a minimum

The premise of the system is that a sale triggers the manufacturing process, therefore Buildup
of work in progress or finished goods needs to be avoided

3. Another drawback is that detailed information for management purposes may not be
available where needed, and the production control therefore need to be all the stronger.

4. The cost accounts used in back-flush accounting may be more difficult to reconcile to financial
accounts needed for reporting

Uses of backflush costing in Cost Accounting :

1. Backflush costing is defined as a streamlined cost accounting method that speeds up,
simplifies, and reduces accounting effort in an environment that minimizes inventory balances,
requires few allocations, uses standard costs, and has minimal variances from standard.
Therefore there is a delay in the costing process until the production of goods or services is
completed. Under this costing method records purchases of raw material and accumulates
actual conversion costs. At a predetermined trigger point such as at the completion of
production or on the sale of goods, an entry is made to allocate the total costs incurred to cost
of goods sold and to finished goods inventory using standard production costs.

2. The Backflush costing is a method of costing a product that works backwards i.e. the standard
costs is allocated to finished products on the basis of the output of a repetitive manufacturing
process. Used where inventory is kept at minimum. This method necessitates the need for
detailed cost tracking required in absorption costing, and usually eliminates separate accounting
for work-in-process. It is also known as Backflush accounting.

3. The Backflush costing as a method is concerned or associated with a just-in-time or JIT

operation. The main goal is to keep the inventory of raw materials low. Therefore the orders for
raw materials are scheduled so that the goods arrive just before the production commences. By
the time materials invoices are received, the goods are produced, costs are calculated, and the
products are sold at a rate that covers the expenses. All the recordings in the company’s
accounting books are made at that point and the books are kept balanced and factual without
making multiple postings all through the production process.
4. There are two drawbacks of this costing method. The Backflush costing is a concept that is
not widely considered to be in compliance with generally accepted accounting principles. It also
lacks the sequential audit trail.
Example of Backflush Cost Accounting :

The following example will be used to illustrate the first two variant outlined above.
The manufacturing cost information for March for a division of XYZ plc is as follows :

Cost incurred in March £’000

Purchase of raw materials 4,250
Labour 2,800
Overheads 1,640

Activity in March Units (‘000)

Finished goods manufactured during the period 180

Sales 145

Standard cost per unit £

Materials 20
Labour 15
Overhead 9

44

There were no opening stocks of raw materials, WIP or finished goods. It should be
assumed that there are no direct materials variance for the period.

Variant 1 :

The double entry would be as follows Dr. Cr.

£’000 £’000

1. RIP account 4,250

Creditor 4,250

2. CC account 4,440
Cash 2,800
Cash/ creditor 1,640

3. FG account (180 X 44) 7,920

RIP account (180 X 20 ) 3,600
CC account (180 X 24 ) 4,320
4. COGS (145 X 44 ) 6,320
FG account 6,380
The ledger would appear as follows

Raw and in process materials



£’000 £’000

Creditor 4,250 FG 3,600

Bal c/d 650

 
4,250 4,250
 

Bal b/d 650

Conversion costs



£’000 £’000

Cash/creditor 4,440 FG 4,320

Bal c/d 120

 -
4,440 4,440
 

Bal b/d 120

Finished goods



£’000 £’000

RIP 3,600 COGS 6,380

CC 4,320 Bal c/d 1,540

 
 7,920 7,920
 

Bal b/d 1,540

Cost of goods sold



£’000 £’000

FG 6,380

The stock balances at the end of March would be

£’000
Raw and in process materials 650
Finished goods 1,540

2,190

The balance on the conversion cost account would be carried forward and written off at the
end of the year.

Variant 2 :

The accounting entries where there is only one trigger point (on completion of units)
would be simpler.
DR CR
£’000 £’000

1. CC account 4,440
Cash 2,800
Cash/creditors 1,640

2. FG account (180 X 44 ) 7,920

Creditors (180 X 20 ) 3,600
CC account (180 X 24 ) 4,320

3. COGS 6,380
FG account 6,380
This variant is thus only suitable for JIT system with minimal raw materials stocks.

Another Example of Backflush Cost Accounting :

The manufacturing cost information for March

Purchase of raw material = $4,250
Labour = $2,800
Overhead = $1,640

Finished good manufactured = 180 units

Sales units = 145 units

Standard cost per unit

Direct material = $20
Direct labour = $15
Overhead = $9

Assume that there were no opening stock of all types and no material variances arise during
March

Answer :

1. Dr. conversion cost $4,440

Cr. Creditor $4,440

2. Dr. Raw & in progress $4,250

Cr. Creditor $4,250

3. Dr. Finished goods $7,920

Cr. Creditor (180 x $20) $3,600
Cr. Conversion cost $4,440

4. Dr. Cost of sales (145 x $44) $6,380

Cr. Finished goods $6,380

Notes :

1) Closing stocks at month end = $1,540

2) Conversion cost = Direct labour + Overhead
3) Conversion cost are not applied to output until they are completed or even sold.
4) All stocks are valued at standard costs.
5) Double entry is unlikely to be examined in this paper, the emphasis is on
explanation and discussion.